Watsco (WSO)

Equipment distributor Watsco (NYSE:WSO) missed Wall Street’s revenue expectations in Q3 CY2025, with sales falling 4.3% year on year to $2.07 billion. Its GAAP profit of $3.98 per share was 7.3% below analysts’ consensus estimates.

Company Overview

Originally a manufacturing company, Watsco (NYSE:WSO) today only distributes air conditioning, heating, and refrigeration equipment, as well as related parts and supplies.

Focusing on narrow product categories that can lead to economies of scale, infrastructure distributors sell essential goods that often enjoy more predictable revenue streams. For example, the ongoing inspection, maintenance, and replacement of pipes and water pumps are critical to a functioning society, rendering them non-discretionary. Lately, innovation to address trends like water conservation has driven incremental sales. But like the broader industrials sector, infrastructure distributors are also at the whim of economic cycles as external factors like interest rates can greatly impact commercial and residential construction projects that drive demand for infrastructure products.

Competitors in the HVAC industry include Carrier Global (NYSE:CARR), Lennox International (NYSE:LII), and Ferguson (NYSE:FERG).

Reviewing a company’s long-term sales performance reveals insights into its quality. Any business can have short-term success, but a top-tier one grows for years. Thankfully, Watsco’s 8.3% annualized revenue growth over the last five years was decent. Its growth was slightly above the average industrials company and shows its offerings resonate with customers.

We at StockStory place the most emphasis on long-term growth, but within industrials, a half-decade historical view may miss cycles, industry trends, or a company capitalizing on catalysts such as a new contract win or a successful product line. Watsco’s recent performance shows its demand has slowed as its annualized revenue growth of 1% over the last two years was below its five-year trend.

This quarter, Watsco missed Wall Street’s estimates and reported a rather uninspiring 4.3% year-on-year revenue decline, generating $2.07 billion of revenue.

Looking ahead, sell-side analysts expect revenue to grow 5% over the next 12 months. Although this projection suggests its newer products and services will fuel better top-line performance, it is still below the sector average.

Gross profit margin is a critical metric to track because it sheds light on its pricing power, complexity of products, and ability to procure raw materials, equipment, and labor.

Watsco’s gross margin is slightly below the average industrials company, giving it less room to invest in areas such as research and development. As you can see below, it averaged a 27.3% gross margin over the last five years. Said differently, Watsco had to pay a chunky $72.73 to its suppliers for every $100 in revenue.

In Q3, Watsco produced a 27.5% gross profit margin, marking a 1.3 percentage point increase from 26.2% in the same quarter last year. Watsco’s full-year margin has also been trending up over the past 12 months, increasing by 1.3 percentage points. If this move continues, it could suggest better unit economics due to some combination of stable to improving pricing power and input costs (such as raw materials).

Operating margin is a key measure of profitability. Think of it as net income - the bottom line - excluding the impact of taxes and interest on debt, which are less connected to business fundamentals.

Watsco’s operating margin might fluctuated slightly over the last 12 months but has remained more or less the same, averaging 10.6% over the last five years. This profitability was solid for an industrials business and shows it’s an efficient company that manages its expenses well. This result was particularly impressive because of its low gross margin, which is mostly a factor of what it sells and takes huge shifts to move meaningfully. Companies have more control over their operating margins, and it’s a show of well-managed operations if they’re high when gross margins are low.

Looking at the trend in its profitability, Watsco’s operating margin might fluctuated slightly but has generally stayed the same over the last five years. This raises questions about the company’s expense base because its revenue growth should have given it leverage on its fixed costs, resulting in better economies of scale and profitability.

This quarter, Watsco generated an operating margin profit margin of 11.4%, in line with the same quarter last year. This indicates the company’s cost structure has recently been stable.

Revenue trends explain a company’s historical growth, but the long-term change in earnings per share (EPS) points to the profitability of that growth – for example, a company could inflate its sales through excessive spending on advertising and promotions.

Watsco’s EPS grew at a remarkable 14% compounded annual growth rate over the last five years, higher than its 8.3% annualized revenue growth. This tells us the company became more profitable on a per-share basis as it expanded.

Like with revenue, we analyze EPS over a more recent period because it can provide insight into an emerging theme or development for the business.

For Watsco, its two-year annual EPS declines of 8.1% mark a reversal from its (seemingly) healthy five-year trend. We hope Watsco can return to earnings growth in the future.

In Q3, Watsco reported EPS of $3.98, down from $4.22 in the same quarter last year. This print missed analysts’ estimates, but we care more about long-term EPS growth than short-term movements. Over the next 12 months, Wall Street expects Watsco’s full-year EPS of $12.80 to grow 9.8%.

Free cash flow isn't a prominently featured metric in company financials and earnings releases, but we think it's telling because it accounts for all operating and capital expenses, making it tough to manipulate. Cash is king.

Watsco has shown decent cash profitability, giving it some flexibility to reinvest or return capital to investors. The company’s free cash flow margin averaged 6.9% over the last five years, slightly better than the broader industrials sector.

Watsco’s free cash flow clocked in at $346.1 million in Q3, equivalent to a 16.7% margin. This result was good as its margin was 6.4 percentage points higher than in the same quarter last year, but we wouldn’t read too much into the short term because investment needs can be seasonal, leading to temporary swings. Long-term trends carry greater meaning.

EPS and free cash flow tell us whether a company was profitable while growing its revenue. But was it capital-efficient? Enter ROIC, a metric showing how much operating profit a company generates relative to the money it has raised (debt and equity).

Although Watsco hasn’t been the highest-quality company lately, it found a few growth initiatives in the past that worked out wonderfully. Its five-year average ROIC was 28.5%, splendid for an industrials business.

We like to invest in businesses with high returns, but the trend in a company’s ROIC is what often surprises the market and moves the stock price. Unfortunately, Watsco’s ROIC has decreased over the last few years. We like what management has done in the past, but its declining returns are perhaps a symptom of fewer profitable growth opportunities.

Businesses that maintain a cash surplus face reduced bankruptcy risk.

Watsco is a profitable, well-capitalized company with $524.3 million of cash and $444.9 million of debt on its balance sheet. This $79.46 million net cash position gives it the freedom to borrow money, return capital to shareholders, or invest in growth initiatives. Leverage is not an issue here.

We struggled to find many positives in these results. Its revenue missed and its EPS fell short of Wall Street’s estimates. Overall, this quarter could have been better. The stock traded down 1.8% to $352 immediately after reporting.

Updated: December 4, 2025 at 10:26 PM EST

When considering an investment in Watsco, investors should account for its valuation and business qualities as well as what’s happened in the latest quarter.

Watsco falls short of our quality standards. Although its revenue growth was good over the last five years, it’s expected to deteriorate over the next 12 months and its diminishing returns show management's prior bets haven't worked out. And while the company’s stellar ROIC suggests it has been a well-run company historically, the downside is its flat same-store sales disappointed.

Watsco’s P/E ratio based on the next 12 months is 27.7x. This valuation tells us a lot of optimism is priced in - we think there are better opportunities elsewhere.

Wall Street analysts have a consensus one-year price target of $408.90 on the company (compared to the current share price of $348.19).

Although the price target is bullish, readers should exercise caution because analysts tend to be overly optimistic. The firms they work for, often big banks, have relationships with companies that extend into fundraising, M&A advisory, and other rewarding business lines. As a result, they typically hesitate to say bad things for fear they will lose out. We at StockStory do not suffer from such conflicts of interest, so we’ll always tell it like it is.